The Federal Reserve rate-cut outlook may have just dodged a bullet as annual CPI revisions out Friday showed core inflation came down in the second half of 2023 as fast as earlier data showed. After the data, the S&P 500 rose solidly to another new record closing high.
CPI Seasonal Adjustment Update
Previous reports had shown core CPI inflation running at a 3.3% annualized rate over the past three months. Revised data left that unchanged.
December's consumer price index rose 0.2% vs. the prior month, down from the 0.3% gain initially reported. Core prices rose slightly slower than first reported in December, 0.275% vs. 0.31%, but that was offset by slightly bigger increases in October and November.
Over the past six months, revised data shows core CPI inflation running at a 3.25% rate vs. 3.21% in earlier data.
Bureau of Labor Statistics revisions on Friday morning affect only the seasonally adjusted CPI data, which means the 3.9% 12-month core inflation rate didn't change.
When it comes to inflation, the recent trend matters almost as much as the 12-month inflation rate. The Fed's primary inflation rate, the core PCE price index, ended 2023 at 2.9%. While that was a big drop from 4.9% in 2022, it is still nearly a full point above the Fed's 2% target.
What really fueled expectations of near-term and significant Fed rate cuts was the plunge in core PCE inflation to a 1.9% annual rate over the second half of 2023, from 4% in the first half.
Fed Gov. Waller: CPI Update Is Key
The best thing to happen to the S&P 500 in 2023 — with the possible exception of the artificial intelligence boom — was the dramatic comedown of inflation in the second half of the year, even as the economy gained steam. Yet Federal Reserve officials had indicated that Friday's consumer price index revisions could alter some of that good news and deal a potential setback to rate-cut expectations.
Last year's seasonal adjustment shift lifted the 3-month annualized rate for core CPI inflation to 4.3% from 3.1% in the fourth quarter of 2022.
In a recent speech, Fed Gov. Christopher Waller made clear that a lot is riding on the updated seasonal adjustments for inflation. "My hope is that the revisions confirm the progress we have seen, but good policy is based on data and not hope."
PCE Vs. CPI Inflation
The CPI and PCE price index are constructed much differently. Housing costs account for over one-third of the CPI's weighting, but just 15% of PCE spending. Health care makes up 16% of PCE spending vs. just 6% of the CPI. That's because the CPI only reflects direct purchases by the consumer, not indirect spending, such as employer payments for employee health care.
Partly because of those differences, core CPI inflation has run at 3.9% over the past year, a full percentage point higher than core PCE inflation.
Still, most of the changes that affect seasonally adjusted CPI data will feed through to the PCE price index. Other PCE data comes from the producer price index, whose seasonal adjustment factors will be updated on Feb. 14.
Federal Reserve Rate-Cut Odds
As of Friday afternoon, after the data revisions, markets were pricing in just 15.5% odds of the first rate cut coming at the March 20 Fed meeting. Markets see 59% odds of a rate cut by May 1, according to CME Group's FedWatch tool.
Markets see a year-end federal funds rate of 4.26%. That implies about 50% odds of five quarter-point rate cuts, and 50% odds of four cuts.
S&P 500
The S&P 500 rose 0.6% in Friday stock market action after the CPI revisions, closing above 5,000 for the first time even as Treasury yields pushed higher.
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